Time for Investors to Join the Crowd?

For any real estate investor, growing one's portfolio is a challenge. It requires financial leverage, which many times means finding an alternative source of funds to close a deal since the investor doesn't necessarily have enough money to self-fund.

As early as the 1930s, real estate syndication has been a viable option, allowing a number of investors to pool their money together in order to take down a high-priced asset -- popular especially in the commercial arena. The alternative -- buying shares of a real estate investment trust -- leaves investors outside of the decision-making process when it comes to deciding which assets are purchased.

"In 1933 they defined a phrase called an investment contract. When someone invests their money in an enterprise with an expectation of profit and someone else does the work," says Gene Trowbridge, a syndication lawyer and author based in Orange County, California. "Syndication was always a restricted way of raising money because you couldn't advertise. Then along comes the Jobs Act that opens up the market and makes the accessing of capital easier and less expensive."

Thanks to computers and the internet, syndication is available to a much larger investor pool than ever before, but with a new high-tech name -- crowdfunding -- and the Jobs Act, which helped codify it by amending the Securities Act of 1933.

"We see a lot of investors who have not been able to invest in commercial property before," says Jilliene Helman, CEO and co-founder of RealtyMogul.com. "A lot of investors don't have the time to manage the real estate, but they want the exposure to real estate investments. Crowdfunding is a good way to get diversification."

Coming of age with the Jobs Act. When President Barack Obama signed it into law in April 2012, the Jumpstart Our Business Startups Act accomplished many things, not the least of which was to formally recognize crowdfunding as a viable means of raising capital for enterprises, but with certain restrictions attached.

Under the old rule -- SEC 506(b) -- companies were allowed to sell shares to accredited investors and up to 35 non-accredited investors, however the offerings could not be advertised. The Jobs Act changed that with the enactment of 506(c), allowing general solicitation and advertising, but only to accredited investors.

The act created a crowdfunding exemption that caps the amount the issuer can raise during any 12-month period to a maximum of $1 million through an authorized crowdfunding portal.

During any 12-month period, the amount any single investor can contribute to all crowdfunding deals is limited to:

-- $2,000 or 5 percent of the annual income or net worth of the investor if either of those is less than $100,000.

-- 10 percent of the investor's annual income or net worth not to exceed an aggregate amount sold of $100,000 if either the investor's annual income or net worth is equal to or greater than $100,000.

Under Rule 506 of Regulation D of the Securities Act, the seller of an asset could sell to an unlimited number of accredited investors; it just could not use advertising or general solicitation to the market those shares.

That changed with Title II of the Jobs Act, which removed the prohibition against general advertising and solicitation of offerings, so long as the investors who purchase shares are verified as accredited investors as defined under the act.

The threshold test under SEC Rule 501 states that a person qualifies as an accredited investor if he or she has:

-- An individual net worth or joint net worth with a spouse exceeding $1 million at the time of purchase excluding the value of a primary residence; or

-- An individual annual income that exceeded $200,000 in each of the two most recent years or a joint annual income with a spouse exceeding $300,000 for those years, and a reasonable expectation of the same income level in the current year.

"To do crowdfunding means to go online and execute. What matters is the underlying asset," Helman says. "One of the things that's better with crowdfunding is that you can invest in smaller asset sizes. A lot of time there's a lot more competition for the larger deals."

Title IV opens the door further. Referred to in the industry as Regulation A+, Title IV of the Jobs Act became effective in June 2015, expanding on some parts of the act that allow more competition to come to the table.

"Crowdfunding companies are leveraging technology to do online what real estate syndicates have been doing for decades -- but crowdfunding levels the playing field, and opens up countless opportunities for thousands of individual investors who have been locked out of the market, especially for more expensive deals, until now," says Rick Sharga, chief marketing officer at online real estate marketplace Ten-X.

"This is a whole new dynamic, and another example of the internet democratizing a transaction -- taking a process which had previously been available to only a select few, and making it transparent, efficient and most importantly, widely available to people who until now had been unable to participate in these types of investments."

Most importantly, Regulation A+ opened the door to anyone -- not just accredited investors -- who wish to participate in the process. So now issuers who are selling shares of their deals can generally solicit and advertise them to the public at large.

"Access to deal flow is the real advantage to this crowdfunding thing," says Mark Robertson, an investor based in Salisbury, North Carolina, who has done dozens of deals using crowdfunding -- some real estate, others investing in funds.

From the investor's perspective. Even though the regulations now allow crowdfunding platforms to market their deals to the general public -- both accredited and non-accredited investors -- Robertson notes that some crowdfunding platforms don't allow access to see the deals available unless they first sign up with the platform and prove they are accredited.

"The good news about these platforms is they weed out 98 percent of the deals they look at. They do the due diligence themselves and pick the cream of the crop, and then I pick the cream of the crop from those," says Roberson, who has invested with a number of crowdfunding platforms.

But as with any real estate investment, Matthew Owens, an investor based in Manhattan Beach, California, stresses the importance of doing one's own due diligence on any investment they are considering.

"As an investor you don't want to rely on someone else to do your homework for you when you don't know their expertise," Owens says. "They do have requirements, but they differ for every platform. They can specialize in specific industry types. And they can give limitations on how large an investment they will work with."

Trowbridge expects that with the advent of regulation crowdfunding, as it is called, there will be a lot of investors looking at debt offerings because, at the end of the day, people just want to see some kind of return on their investment.

"You choose the investment so it's different than a REIT. It's an awesome thing that people can choose other asset types outside of the stock market, going through the smaller guys instead of big corporations," Owens says.

As with any investment scenario, things can go south and deals can go bad when it comes to dealing with real estate. But so far Robertson says he does not know of anyone who has lost any equity in a crowdfunding deal.